RFC Investment Strategies & Portfolio Management 3 — Questions and Answers
Question 1: Which investment strategy aims to replicate the risk/return profile of a liability stream, minimizing the surplus volatility between assets and liabilities?
- Liability-Driven Investing (LDI) (Correct answer)
- Goals-Based Investing (GBI)
- Constant Proportion Portfolio Insurance (CPPI)
- Risk Parity
Correct answer: Liability-Driven Investing (LDI)
LDI structures the asset portfolio to match the duration and cash flow characteristics of liabilities, reducing funded-status volatility.
Question 2: The Black-Litterman model improves upon mean-variance optimization primarily by:
- Eliminating the need for an efficient frontier
- Incorporating investor views with market equilibrium returns (Correct answer)
- Maximizing the Sharpe ratio subject to turnover constraints
- Using Monte Carlo simulation instead of historical data
Correct answer: Incorporating investor views with market equilibrium returns
Black-Litterman blends the investor's subjective views with implied equilibrium returns derived from market capitalization weights to produce more stable portfolios.
Question 3: A 60/40 portfolio refers to an allocation of:
- 60% domestic equities and 40% international equities
- 60% equities and 40% fixed income (Correct answer)
- 60% large-cap and 40% small-cap stocks
- 60% passive funds and 40% active funds
Correct answer: 60% equities and 40% fixed income
The classic 60/40 portfolio allocates 60% to equities for growth and 40% to bonds for stability and income, serving as a traditional balanced benchmark.
Question 4: Which scenario best illustrates a 'barbell' fixed income strategy?
- Equal allocation across all maturities from 1 to 30 years
- Heavy allocation to intermediate-term bonds only
- Concentration in short-term and long-term bonds with little intermediate exposure (Correct answer)
- Investing only in investment-grade corporate bonds
Correct answer: Concentration in short-term and long-term bonds with little intermediate exposure
A barbell strategy concentrates holdings at both ends of the maturity spectrum, balancing liquidity from short-term bonds with yield from long-term bonds.
Question 5: What is 'portable alpha' in portfolio management?
- Alpha generated by rotating sector exposure based on economic cycles
- Separating alpha generation from beta exposure and overlaying alpha onto any benchmark (Correct answer)
- Using derivatives to transport returns across asset classes tax-efficiently
- A passive strategy tracking an alpha-tilted smart beta index
Correct answer: Separating alpha generation from beta exposure and overlaying alpha onto any benchmark
Portable alpha uses derivatives to gain desired market (beta) exposure while separately investing in an alpha-generating strategy, decoupling the two return sources.
Question 6: Which risk measure focuses solely on the downside deviation below a target return, unlike standard deviation which penalizes upside volatility equally?
- Value at Risk (VaR)
- Conditional VaR (CVaR)
- Sortino ratio denominator (downside deviation) (Correct answer)
- Maximum drawdown
Correct answer: Sortino ratio denominator (downside deviation)
Downside deviation, used in the Sortino ratio, only counts returns that fall below the minimum acceptable return, ignoring favorable upside volatility.
Question 7: An RFC advisor recommends increasing a client's international equity allocation from 15% to 30%. Which risk is most directly increased by this change?
- Interest rate risk
- Currency risk (Correct answer)
- Inflation risk
- Liquidity risk
Correct answer: Currency risk
Increasing international equity exposure raises currency risk because foreign-denominated returns must be converted back to USD, adding exchange rate volatility.
RFC Investment Strategies & Portfolio Management 3
Which investment strategy aims to replicate the risk/return profile of a liability stream, minimizing the surplus volatility between assets and liabilities?